Risk of runaway inflation likely low

Covid-19 has kept consumers from their usual spending habits, with the resulting pent-up demand expected to drive the economy during recovery. While concern has arisen that renewed spending could mean out-of-control inflation, that likely won’t be the case, RBC Economics said in a report on Wednesday.

The report said a “firming” in underlying prices can be expected in the coming months as oil prices rebound and consumers spend more — especially in sectors such as travel and hospitality. Inflation could reach or exceed the Bank of Canada’s 2% target in 2022, spurring the central bank to begin raising its key interest rate, the RBC report said.

However, inflation concerns shouldn’t be overstated.

“Even though they make headlines, large consumer price increases have been the exception rather than the rule,” wrote the report’s authors, Nathan Janzen and Claire Fan.

For example, energy-price inflation readings will ease later this year as oil-price drops from a year ago fall out of year-over-year price calculations, the report said.

Also, the complexity of international supply chains will likely prevent rising input prices from having a “rapid, broad effect” on consumer prices.

The greater risk tends to be expectations for inflation, which can be a self-fulfilling prophecy. To avoid that, businesses must be confident that the Bank of Canada will act to keep inflation from rising beyond its 2% target, the report said. If they are, they’ll refrain from passing on price increases to consumers.

So far, inflation expectations seem to be in check. More than 80% of businesses expected inflation to remain within the 1% to 3% target range over the next two years, according to the Bank of Canada’s latest survey.

RBC also said increased retail competition, both online and brick-and-mortar, will help keep inflation from rising excessively, “with consumers likely to benefit from price competition.”

Further, demographics and innovation are “powerful forces at work” that will likely keep a lid on longer-term inflation, wrote Kristina Hooper, chief global market strategist with Invesco, in a blogpost this week.

“While I think it’s very possible that we get a short-term increase in inflation on a surge in spending as the economy re-opens, I don’t believe we will see a longer-term increase in inflation,” Hooper said.

Staff

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